Question

Assume you are the manager of ground operations for Hoepker Airlines at the Metro Airport. You have just been informed that the plane size between Phoenix and New York will be increased from a Boeing 737 to a 727 and is expected to generate 50 additional passengers per flight. What ground operations costs do you think will increase because of the additional 50 passengers per flight? What ground operations will not be affected? Which of these costs will be fixed costs and which are variable? How will the increase in the number of passengers affect the calculation of Hoepker's break–even point for a flight?

Answer 1

Variable costs are defined as costs that go up or down depending upon the usage of the airplane. For example, as the aircraft usage hours increase, the variable cost will increase as well even though the cost per unit stays the same. For example, the more hours that fly your airplane, the higher the total fuel cost will be. Therefore, fuel is a variable cost.

Examples of Variable and Fixed Costs

Common examples of variable costs include:

• Fuel
• Oil
• Landing Fees
• Catering
• Crew Expenses, such as travel, hotel and per diem expenditures when taking trips
• Crew salaries, if paid per flight hour. When crew members are paid on an hourly, the cost incurred is a variable cost. Conversely, when crew members are paid an annual salary, the cost is considered a fixed cost.

• Maintenance. Most aviation organizations consider all maintenance costs as variable costs. Some, however, consider certain aspects of aircraft maintenance as fixed costs. Annual inspections, for example, are typically scheduled and must be completed whether the airplane flies ten hours or 1,000 hours per year. This leads some operators to consider this type of maintenance a fixed cost. The same can be true of scheduled overhauls and avionics updates. These costs can be considered fixed costs because they don’t necessarily change with aircraft usage. However, regular or unscheduled maintenance costs tend to vary due to the fixed cost per unit (i.e., the hourly rate a maintenance facility might charge). Logically, the more an airplane flies, the more maintenance hours will be required to maintain it.

It's important to note that the more hours you fly an airplane, the less you'll be paying per hour for your variable costs. There's another variable to measure, and that's the cost per nautical mile. A jet, for example, will have a much higher cost per hour than a piston aircraft, but it can also deliver you much farther in far fewer hours, so you'll spend fewer hours in the air for the same trip.

Fixed costs, as opposed to variable costs, are defined as costs that remain the same over a period of time. Conversely, variable costs are subject to change and include things like fuel, oil, maintenance, landing fees, etc. An aircraft’s fixed costs remain the same no matter how many hours you fly your plane. However, the "cost per unit" of a fixed cost will increase (or decrease) depending on the level of activity of the airplane. For example, if your fixed cost is insurance, you will pay the same rate no matter how much the airplane flies each year. If your insurance costs $1,200 dollars per year, and you fly the airplane for 100 hours each year, your hourly insurance cost is $12 per hour.

However, if you fly the airplane more often (let's say 200 hours each year) then your insurance "cost per hour" drops to $6 per hour. This is why you'll often hear aircraft owners say that they need their airplane to fly more in order to keep costs down.

Examples of Fixed Costs

Some examples of fixed costs include the following:

• Aircraft financing (whether on a lease or loan payment basis)
• Insurance
• The purchasing of books, charts, and materials
• Hangar rental
• Taxes and FAA registration fees
• Aircraft accessories
• Crewmember salaries, if they are paid a fixed annual salary. If a crew member is paid by the flight hour, on the other hand, it is considered a variable cost because the cost depends on the activity level of the airplane.

The cost per unit, or cost per flight hour, can be decreased with an increase in aircraft use. Overall, pilots like to say that they get more “bang for your buck” when they fly more hours. For example, if you rent hangar space for $6,000 per year and fly your airplane 100 hours per year, your cost per hour for the hangar rental is $60. If you rent the same hangar but only fly 500 hours per year, your cost per flight hour decreases to $12 per hour.

It's important to recognize (and plan ahead) for both fixed and variable costs when you become an aircraft owner or operator. All too often, aircraft owners are surprised by the additional costs they encounter after purchasing an airplane. Knowing both the fixed (and variable) costs of air travel, aircraft usage, and aircraft maintenance will determine if you can afford this hobby and if so, help to keep your budget in check.

The industry’s typical way of comparing expenses—the cost per available seat kilometer (CASK)—has its limits: the aggregated results don’t provide much insight into the reasons for changing costs.

The major expenses that affect companies in the airline industry are labor and fuel costs. Labor costs are largely fixed in the short-term, while fuel costs can swing wildly based on the price of oil.

For this reason, analysts pay more attention to fuel costs in the near-term. Two-thirds of the costs of flying an airplane are fixed, so changes in fuel costs can swing a flight from profit to loss depending on how many people are on the flight.

Historically, the airline industry continues to be brutally competitive, even though the business of flying people all over the world and country has become an integral part of human life. The cost of flying continues to trend lower. The Internet has also created greater price transparency, reducing margins.

Cost of Labor for Airlines

Labor accounts for approximately 35% of the total of airlines' operating expenses. Operating expenses account for roughly 75% of all non-fixed costs.

During downturns, management looks to cut labor costs by laying off workers or reducing their pay or benefits. This is a consequence of being in a competitive business where customers have little brand loyalty — airlines generally have to compete on price rather than quality. Since growing profits is difficult, companies are forced to cut costs to be more profitable.

Some of the lesser expenses for airlines are maintenance, parts and labor, handling luggage, airport fees, taxes, marketing, promotions, travel agent commissions and passenger expenses. As a whole, these account for nearly 55% of total operating costs.

Cost of Fuel for Airlines

Fuel costs account for 10 to 12% of operating expenses. Many companies have programs to hedge fuel costs. They buy futures contracts to lock in their costs for a set period of time, turning it into a fixed expense. When fuel prices rise, this behavior is rewarded. When fuel prices decline, this is punished as the market price of fuel is less than what they are paying.

Some of the worst times for airlines have been when oil prices spiked up. Airline companies can prepare for slowly rising prices by charging more for tickets or by reducing the amount of flights, but sudden moves higher lead many airlines to lose money.